Fundamental Outlook for US Dollar: Bullish

- Dollar capitalizes on mounting financial instability through its safe haven status
- A late-week surge for the dollar helped along by a jump in consumer confidence, spending
- Technicals and fundamentals clash for EURUSD outlook

There is a trend developing. The US dollar has produced notable rallies at the end of each of the past four weeks. The past two advances are the most notable. Both have come on the back of exceedingly strong economic data – the drive on the 5th was the product of strong NFPs and a drop in the unemployment rate; while the rally on the 12th would come through the merits of a strengthening consumer on sentiment and spending. This would seem a straightforward reaction to data, right? Actually, this would contradict the normal pace that the market has carved for the greenback for the past nine months where strong economic data has bolstered risk appetite and directly weighed on the dollar as a safe haven currency. So, what does this mean? Is the dollar’s role in the risk appetite backdrop changing? Is sentiment actually weaker than just the US data would suggest? Both are likely true. With the dollar looking for strength through various market conditions, the currency may be developing a meaningful bullish trend. However, playing on the well-established, fundamental roles that have been in control for over a year; a collapse in broad investor sentiment is still the most accessible catalyst for a true dollar bull trend.

As has been the case for the full year, the primary fundamental concern for the US dollar going forward is the general bearing and force of risk appetite. From this, there are two concerns. As always, identifying and measuring the influence of potential catalysts is of primary importance; but now, we also have to gauge the currency’s relationship to risk appetite itself. In the past few weeks, while the dollar’s advance has been somewhat choppy and more prominent in certain pairs (EURUSD being the most remarkable example); it has come on strong local data and developed despite stability in other key risk-sensitive markets. This is a natural development considering markets held to congestion for nearly two months now at the top of an unprecedented rally; and the dollar has carried the brunt of the burden in funding this drive. Beyond just a general dissolution of correlations, though; there are fundamental reasons for the dollar to move up the yield spectrum. The United State’s economic recovery is among the strongest in the industrialized world, the Federal Reserve is actively reducing its stimulus and the financial stability in the US markets is comparable (if not more established) to its global counterparts. All that being said, a collapse in risk appetite that balances speculative interests through profit taking is still the most capable driver for the dollar. Not only would capital return to the safety of US Treasuries and money market funds; but it would be drawn out of emerging markets and other risky areas and put into the more liquid but yield-bearing instruments in the US.

For the more definable sense of risk in this coming week’s economic docket; there is plenty of data to feed the more established fundamentals trends. For interest rate forecasts, the market is targeting the Fed’s first hike around the middle of the year – in line with Governor Bernanke’s time frame. However, such projections are not set in stone by policy makers and traders know this. The FOMC rate decision on Wednesday will offer an update on how close a hike may be. Also, interesting in this event will be any mention of more measured changes to policy like the slow withdrawal of stimulus. Realistically, stimulus and interest rates can be adjusted separately. If financial aid is maintained and rates raised, it could support the economy, help dampen any inflation that may pop up and revive the dollar. Other noteworthy indicators on deck included the CPI stats, industrial production, housing starts and the vote to lift the deficit limit.

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